Microsoft's $10 billion bet on ChatGPT's maker gives it a powerful new weapon in the cloud wars with Amazon and Google

• Microsoft's multibillion-dollar bet on OpenAI could be rocket fuel for its cloud business.
• Cloud, increasingly important to Microsoft, Amazon, and Google, is slowing down in the short term.
• But whoever successfully integrates AI could dominate the market.

Microsoft opened Wednesday with a 4% share price drop after the firm gave a tough outlook for its cloud business during third-quarter earnings Tuesday. But the company has a longer-term strategic weapon that could help it win the cloud wars: its once-in-a-generation bet on OpenAI.

Reporting fiscal Q1 earnings on Tuesday, Microsoft forecast that its cloud business Azure would slow by 4-5 percentage points in the coming quarter. The deceleration is down to customers shying away from expensive cloud deals in a tough macroeconomic environment. The unit generated $25.7 billion in revenue in its most recent quarter, up 24% year on year. 

Cloud computing has taken off over the last decade as a way for blue-chip businesses to store massive amounts of information on servers run by the major tech firms, rather than on-premise. For the most part, it's faster, more secure, and flexible.  

It's also a huge revenue driver for Big Tech, whatever their public spiel about self-driving cars and acrobatic robots. An outage at market leader Amazon's AWS can take down large swathes of the internet. Any hint of a slowdown in growth for Microsoft's Azure, Amazon's AWS, and Google Cloud tends to provoke analyst angst. 

Microsoft CEO Satya Nadella — who once ran its cloud division — accordingly provoked some of this angst as he warned that the firm's Azure customers were beginning to "optimize" their cloud spend after a pandemic binge.

But, he added: "We fundamentally believe that the next big platform wave is going to be AI and we strongly also believe a lot of the enterprise value gets created by just being able to catch these waves and then have those waves impact every part of our tech stack and also create new solutions and new opportunities."

Even if there are immediate challenges for cloud growth, Microsoft sees its OpenAI bet, reported to be worth $10 billion, as a bigger strategic move. As a gamble, it looks smarter than, say, the metaverse.

Armed the deadliest weapon yet

In a blogpost announcing the deal, Microsoft noted that its investment in the developer behind the generative AI chatbot would help it build "leading AI infrastructure" for Azure. In practice, this means developing cloud technologies that are purpose-built for AI, giving it an edge at a time when excitement among developers for AI is peaking. 

Microsoft's gamble, essentially, is that everyone will need and use artificial intelligence in the near future — and that means increased demand and cash for the computing power to train AI models.

A research note on Wednesday from Jefferies analysts noted Microsoft "sees AI innovation as driving growth for Azure AI services," with revenue from Azure ML, a cloud segment dedicated to training AI models, increasing more than 100% over the past five quarters. 

Microsoft also suggested in its post that it will make Azure the "exclusive cloud provider" of OpenAI's research and products.

All of this is "mostly about cementing Azure's edge over AWS" as Microsoft "has exclusive access to the hottest AI property on the market right now," according to Richard Windsor, founder of research firm Radio Free Mobile.

Windsor thinks that much of the money Microsoft is committing to OpenAI will revolve around "building custom infrastructure"  to run OpenAI's technology in an efficient way, given that "during busy times, response times increase materially" for its scary-smart chatbot, ChatGPT. 

The bet is that Azure could offer OpenAI to customers in a way that none of its rivals can immediately replicate.

"Should OpenAI's products become popular with clients, this will give Azure firepower in its quest to close the gap on AWS," he said. 

The AI arms race

With cloud spend tightening, it's likely that Amazon and Google will look to give their cloud divisions a shot in the arm too with AI to stay competitive. Amazon will want to retain its lead position, Google is pursuing an aggressive growth plan.

"This isn't a vacuum," said Bola Rotibi, chief of enterprise research at CCS Insight. "You can imagine Amazon is not going to be sitting on its laurels or waiting there for Microsoft to surpass it."

 Cloud represents a growing slice of Big Tech's respective revenue pies. Microsoft Cloud, which also includes revenue from Office 365 and other products as well as Azure, represented around 50% of the company's overall revenue. In Amazon's last earnings, AWS represented around 16% of its overall earnings, while Google Cloud's $6.9 billion in revenue at the end of the September quarter represented 10% of overall revenue.

These percentage figures are likely to get bigger.

In a research note on Tuesday, Wedbush analysts Dan Ives and John Katsingris wrote that cloud and the underlying Office ecosystem "is going to comprise a bigger and bigger piece of Redmond going forward and will ultimately spur growth and margins" despite the downturn.

"We believe the shift to cloud is still less than 50% penetrated and represents a massive opportunity for Nadella & Co. going forward despite the dark storm clouds forming for FY23 in the uncertain macro backdrop," the Wedbush analysts said. 

There is pressure right now on cloud spend, with Wedbush predicting some "larger cloud deals" in the financial sector will likely get downsized for Microsoft as companies rein in costs.

But the AI genie is out of the bottle, as evidenced by the proliferation of activity around ChatGPT. Microsoft's OpenAI bet looks smarter by the day.